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California’s LCFS mandate sets global risk management challenge

California’s LCFS ticketing market for low carbon intensity fuels has been back in record breaking form for much of this year. Driven by the “hockey stick” shaped build in carbon intensity reduction schedules, ticket price this week hit an all-time high of $185 after averaging $162 through the second quarter, up over 115% from the second quarter of 2017.

The unstoppable rise of California’s low carbon fuel demand has already recalibrated the national biodiesel and renewable diesel markets toward an increasing focus on the West Coast, stretching California-focused risk management requirements across North America. California’s pricing effect is also rippling through world renewable fuel and feedstock markets, increasing competition with European buyers for low-carbon feedstocks alongside an appetite for international producers to qualify to sell refined fuel or feedstock into the California system.

The past two years have seen California claim the crown as by far the largest state consumer of biodiesel in the US, dwarfing national refining hub Texas in 2017 and 2018 to date. California’s relatively small pool of domestic biodiesel production plants leaves the state heavily dependent on national and international imports. Current ticket prices in the state offer a producer of generic waste-oil based biodiesel with a low carbon intensity monetary incentives of more than $1.80/gal, shading the underlying attractions of the volumetrically far larger but lower pricing Federal RIN-ticketed market and its long-standing partner, the politically uncertain blender’s tax credit.

How does it work?

LCFS standards are expressed in terms of the “carbon intensity” (CI) of gasoline and diesel fuel and their respective substitutes.

“Regulated parties” (RPs) producing and distributing transportation fuel in California are subject to an annual requirement to reduce carbon intensity across their fuel pool which is made increasingly demanding year after year.

Companies supplying accredited reduced carbon intensity fuel into California are issued tickets equivalent to each tonne of carbon their sales reduced relative to fossil fuel substitutes. These tickets are then eligible for resale to obligated parties in a secondary OTC market before retirement into California Air Resources’ Board’s annual compliance bank. Tickets each represent carbon emissions reduction equivalent to one tonne of CO2 equivalent. PRIMA prices underlying CME’s financially settled LCFS swap reflect the physical liquidity in the OTC market weighted towards each day’s close.

Who’s involved

On the demand side, CARB currently designates 267 firms as RPs subject to LCFS compliance and program price risk. These entities are ranged across the US. They include oil majors, independent refiners, petroleum fuel importers and distributors, and trading firms. Between 10-20 firms regularly buy credits directly or through brokers to meet their compliance obligations.

On the supply side, CARB lists 472 separate low carbon intensity fuel supply pathways eligible towards credit generation.

Between 10-20 firms regularly sell credits to meet their compliance obligations. These pull production entities from as far afield as Singapore and Brazil into the LCFS orbit alongside pan-US and Canadian firms. More international system registrations are expected to follow as carbon intensity reduction schedules ratchet higher.

Enhancing equity

Current California policy deliberations look set to continue supporting a high pricing market. This will encourage scale sales of renewable fuel from well beyond California’s borders, positioning LCFS ticket prices as a fixture of quarterly earnings reporting at renewable fuel firms including REG, Diamond Green and Finnish renewable diesel refiner Neste.

International renewable diesel giant Neste, which steers around a third of its global renewable diesel production slate into the US West Coast, describes the long-term demand outlook in the California market as “very very positive”.
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